NY Securities Financing Forum: What effect will the current regulatory changes have on the securities financing industry?

Following is a recap of the Regulatory Panel from today's New York Securities Financing Forum.

"What effect will the current regulatory changes have on the securities financing industry?"

Panelists:

• Steven Lofchie, Partner, Cadwalader Wichersham & Taft
• Mike McAuley, Managing Director, Securities Lending Senior Business Strategist, BNY Mellon
• Rebecca Nordhaus, Member of RMA Committee on Securities Lending
• Steven Pesek, Supervising Examiner, The Federal Reserve Bank of New York
• Moderator Will Duff Gordon, Research Director, Data Explorers

The challenge when discussing how things like Dodd Frank will affect this industry is to avoid leaving the impression that these changes will make business more difficult full stop. Of course, the sheer number of proposed changes are very daunting but no one should underestimate the ability banks have to adapt and move on to make money in a different way. A couple of panelists indicated that if the regulators could be persuaded, defaulted companies being placed in a “bridge status,” might be a beneficial situation.

Audience polling:

• 49% indicated that 10-25% of their time is now devoted to regulatory/compliance issues, with 34% spending less than 10%.
• Majority of attendees (54%) admit they are “a little” worried about short selling disclosure regulations impacting their business in a negative way. 50% do not intend to respond to SEC’s consultation paper on short selling disclosure regulations, with 34% saying they will, and only 6% having done so already.
• Majority of attendees think that US real time reporting of short positions will most impact lending demand.

So many unknowns with Dodd Frank: A huge amount of time is currently being spent on regulatory issues. Institutions as a whole spend a lot of time. Most people aren’t clear as to how the issues will specifically affect them, so prioritization is key, or too much time will be spent unnecessarily. Regulators now get more requests coming to them for clarification on Dodd Frank than they have going out to industry.

One regulator on the panel, speaking strictly from a personal view, “At what point do people policing the regulations outnumber the folks actually trading?” He is currently spending 50% more of his times inside the institutions he’s regulating, regardless of Dodd Frank in order to fully understand their challenges.

It’s clear that it’s very important to be engaged with and help educate the regulators – regulators are very open and want to better understand potential impact of regulations.

Steven Lofchie of Cadwalader Wickersham and Taft said to a chuckling audience, “If politicians are wondering why Wall Street thinks the regulations are stupid, I'll be glad to let them know what the answer is if they’ve got 6 – 8 hours to spare."

Anticipated regulatory changes are limited in the overall scale, given that most of Dodd Frank is not about securities financing. With an aspect of Dodd Frank about to go into effect, rules around swap transactions are remarkable given that nobody really knows where they are going to book transactions – many of the vehicles they’re currently using will be unusable as regulations go into effect, and there is no clear explanation from regulators yet, as to what to do come July 16th.

Another big issue is that the statues could establish a wall across the Atlantic. Said one panelist, "the system in US not good at all.  It is punitive and very US-centric – not likely the European regulators will accept such prohibitive rules for overseas banks."

Said another panelist, “it is unimaginable tohave a system when the question is not ‘how do I do this trade?’ but rather, ‘in which vehicle can I execute that is still permissible?’”

Stock lending is a type of transaction where you can get out very quickly, which is good given that many counterparts are now far more aware of the risks post Bear/Lehman. There are ancillary Dodd Frank regulations important to stock loans: the elevation of both requirements for collateral and elevation of type of collateral required to post (i.e. regulated futures market). There are more and more restrictions as to the types of collateral that can be posted, and we are likely to see a spillover effect in the securities lending market as it becomes more important as to what types of collateral a lender is willing to accept. It was suggested on the panel that the lenders who are more willing to accept types of collateral other than Govvies or cash will have the advantage.

Lofchie suggested that regulators should find a way for Beneficial Owners to partake in term lending: to manage their capital adequacy, brokers increasingly need to borrow on a term basis. Another panelist underscored that capital adequacy is a big provision of Dodd Frank, and there must be coordination between BASLE III and Dodd Frank.

The major takeaway from this discussion is that when designing laws, the regulators would do well to bear in mind how the traders are going to react. They may start unwinding positions sooner, having learned from the Bear/Lehman crisis. With the current proposals, traders are likely to simply not trade if the rules are not altered.